“Fatally Flawed” Paper on HAMP Mortgage Program Gets Program Design Backwards, Botches Regression Analysis, Yielding Propagandistic Findings

Yves here. The pipe-bombing attempts of foreclosure victim Cesar Sayoc is a reminder that the damage done by the mortgage crisis lives on in many ways.

Carolyn Sissoko does an in depth takedown of a new paper on the HAMP mortgage program, which was a major tool that Treasury Secretary Timothy Geithner used to “foam the runway” for banks servicers. To put it more bluntly, its objective was spread out foreclosures over time by (merely) delaying the onset of some. As many parties, including your humble blogger, argued at the time, even when borrowers did get modifications, they were typically only payment reductions and not even forgiveness of some of the interest. The term of the mortgage and the principal were often both increased, meaning the borrower was merely allowed to defer some of his outlay. By contrast, we argued that meaningful reductions in principal were economically sound, particularly since, due to the high level of foreclosures, losses were much higher than historical norms. Lenders used to recover ~70% in a foreclosure. In the post crisis era, 30% to 40% was more common, giving vastly more room for principal writedowns that would help investors, borrowers, and communities.

The wee problem with this line of thinking was that mortgage servicers were paid to foreclose, not to modify loans, and modifying loans well is a lot of work. Second, in a mortgage securitization, the owners of the most junior bond tranche that was still paying out would lose out in a modification (they’d be getting interest only payments, which would disappear in a principal mod due to the interest obligation being reduced along with the principal) and they’d fight modifications.1

Today, we will post Sissoko’s overview and first post, and will publish her second installment Thursday and her final piece Friday.

By Carolyn Sissoko, who has a PhD in economics from UCLA and a JD from the University of Southern California. She is an independent researcher who writes on financial regulation, the history of banking, and monetary theory. Originally published at Synthetic Assets

HAMP and Principal Reduction: An Overview

I spent the summer of 2011 helping mortgage borrowers (i) correct bank documentation regarding their loans and (ii) extract permanent mortgage modifications from banks. One of things I did was check the bank modifications for compliance with the government’s mortgage modification program, HAMP, and with the HAMP waterfall including the HAMP Principal Reduction Alternative. At that time I put together HAMP spreadsheets, and typically when I read articles about HAMP I go back to my spreadsheets to refresh my memory of the details of HAMP.

So when I learned about a paper that finds that HAMP “placed an inefficient emphasis on reducing borrowers’ total mortgage debt” and should have focused more on reducing borrowers payments in the short-run — which goes contrary to everything I know about HAMP, I decided to read the paper.

Now I am an economist, so even though my focus is not quantitative data analysis, when I bother to put the time into reading an econometric study it’s not difficult to see problems with the research design. On the other hand, I usually avoid being too critical, on the principle that econometrics is a little outside the area of my expertise. In this case, however, I know that very few people have enough knowledge of HAMP to actually evaluate the paper — and that many of those who do are interested parties.

The paper Peter Ganong and Pascal Noel’s Liquidity vs. wealth in household debt obligations: Evidence from housing policy in the Great Recession. This paper has been published as a working paper by the Washington Center for Equitable Growth and NBER, both of which provided funding for the research. Both the Wall Street Journal and Forbes have published articles on this paper. So as one of the few people who is capable offering a robust critique of the paper, I am going to do a series of posts explaining why the main conclusion of this paper is fatally flawed and why the paper reads to me as financial industry propaganda.

Note that I am not making any claims about the authors’ motivation in writing this paper. I see some evidence in the paper to support the view that the authors were manipulated by some of the people providing them with the data and explaining it to them. Overall, I think this paper should however serve as a cautionary tale for all those who are dependent on interested parties for their data.

Here is the overview of the blogposts I will post discussing this paper:

HAMP and principal reduction post 1: The ideology of financialization

HAMP and principal reduction post 2: What’s the problem with financialization?

HAMP and principal reduction post 3: A regression discontinuity error
The principal result in the paper is invalid, because the authors did not have a good understanding of HAMP and of HAMP PRA, and therefore did not understand how the variable they use to distinguish treatment from control groups converges to their threshold precisely when principal reduction converges to zero. The structure of this variable invalidates the regression discontinuity test that the authors perform.

The Ideology of Financialization

The analysis in Peter Ganong and Pascal Noel’s Liquidity vs. wealth in household debt obligations: Evidence from housing policy in the Great Recession is an object lesson in the ideological underpinnings of “financialization”. So this first post in my HAMP and principal reduction series dissects the general approach taken by this paper. Note that I have no reason to believe that these authors are intentionally promoting financialization. The fact that the framing may be unintentionally ideological makes it all the more important to expose the ideology latent in the paper.

The paper studies government and private mortgage modification programs and in particular seeks to differentiate the effects of principal reductions from those of payment reductions. The paper concludes “we find that principal reduction that increases housing wealth without affecting liquidity has no significant impact on default or consumption for underwater borrowers [and that] maturity extension, which immediately reduces payments but leaves long-term obligations approximately unchanged, does significantly reduce default rates” (p. 1). The path that the authors follow to arrive at these broad conclusions is truly remarkable.

The second paragraph of this paper frames the analysis of the relative effects of modifying mortgage debt by either reducing payments or forgiving mortgage principal. This first post will discuss only the first three sentences of this paragraph and what they imply. They read:

The normative policy debate hinges on fundamental economic questions about the relative effect of short- vs long-term debt obligations. For default, the underlying question is whether it is primarily driven by a lack of cash to make payments in the short-term or whether it is a response to the total burden of long-term debt obligations, sometimes known as ‘strategic default.’ For consumption, the underlying question is whether underwater borrowers have a high marginal propensity to consume (MPC) out of either changes in total housing wealth or changes in immediate cash-flow.

Each of the sentences in the paragraph above is remarkable in its own way. Let’s take them one at time.

First sentence

The normative policy debate hinges on fundamental economic questions about the relative effect of short- vs long-term debt obligations.

This is a paper about mortgage debt – that is, long term debt – and how it is restructured. This paper is, thus, not about “the relative effect of short- vs long-term debt obligations,” it is about how choices can be made regarding how long-term debt obligations are structured. This paper has nothing whatsoever to do with short-term debt obligations, which are, by definition, paid off within a year and  do not figure in paper’s analysis at any point.

On the other hand, the authors’ analysis is short-term. It evaluates data only on the first two to three years (on average)  after a mortgage is modified. The whole discussion takes it as given that it is appropriate to evaluate a long-term loan over a horizon that covers only 5 to 10% of its life, and that we can draw firm conclusions about the efficiency of a mortgage modification by only evaluating the first few years of the mortgage’s existence. Remember the authors were willing to state that “principal reduction … has no significant impact on default or consumption for underwater borrowers” even though they have no data on 90 – 95% of the performance of the mortgages they study (that is, on the latter 30-odd years of the mortgages’ existence).

Note that the problem here is not the nature of the data in the paper. It is natural that topical studies of mortgage performance will typically only cover a portion of those mortgages’ lives. But it should be equally natural that every statement in the study acknowledges the inadequacy of the data. For example, the authors could have written: “principal reduction … has no significant impact on immediate horizon default or immediate horizon consumption for underwater borrowers.” Instead, the authors choose to discuss short-term performance as if it is all that matters.

This focus on the short-term, as if it is all that matters, is I would argue the fundamental characteristic of “financialization.” It is also the classic financial conman’s bait and switch. The key when selling a shoddy financial product is to focus on how good it is in the short-term and to fail to discuss the long-term risks. When questions arise regarding the long-term risks, these risks are minimized and are not presented accurately. This bait and switch was practiced on municipal borrowers who issued adjustable rate securities and purchased interest rate swaps, on adjustable rate mortgage borrowers who were advised that they would be able to refinance before the mortgage rate adjusted up, and even on the Trustees of Harvard University, who apparently entered into interest rate swaps without bothering to understand to long-term obligations associated with them.

The authors embrace this deceptive framework of financialization whole-heartedly throughout the paper by discussing the short-term performance of long-term loans as if it is all that matters. While it is true that there are a few nods in footnotes and deep within the paper to what is being left out, they are wholly inadequate to address the fact that the basic framing of the paper is extremely misleading.

Second sentence

For default, the underlying question is whether it is primarily driven by a lack of cash to make payments in the short-term or whether it is a response to the total burden of long-term debt obligations, sometimes known as “strategic default”2

The second sentence is based on the classic distinction between a temporary liquidity-driven stoppage of payments and a stoppage due to negative net worth – i.e. insolvency. (Note that these are the two long-standing reasons for filing bankruptcy.) But the framing in this sentence is remarkably ideological.

The claim that those defaults that are “a response to the total burden of long-term debt obligations” are “sometimes known as ‘strategic default’” is ideologically loaded language. Because the term “strategic default” has a pejorative connotation, this sentence has the effect of putting a moralistic framing on the problem of default: liquidity-constrained defaults are implicitly unavoidable and therefore non-strategic and proper, whereas all non-liquidity-constrained defaults are strategic and implicitly improper. This framing ignores the fact that a default may be due to balance sheet insolvency, which will necessarily be “a response to the total burden of long-term debt obligations” and yet cannot be classified a “strategic” default. What is commonly referred to as strategic default is the case where the debtor is neither liquidity constrained, nor insolvent, but considers only the fact that for this particular asset the payments are effectively paying rent and do not build any principal in the property.

By linguistically excising the possibility that the weight of long-term debt obligations leads to an insolvency-driven default, the authors are already demonstrating their bias against principal reduction and once again exhibiting the ideology of financialization: all that matters is the short-term, therefore balance sheet insolvency driven by the weight of long-term debt does not need to be taken into account.

In short, the implicit claim is that even if the borrower is insolvent and not only has a right to the “fresh start” offered by bankruptcy, but likely needs it to get onto his or her feet again, this would be “strategic” and improper. Overall, the moralistic framing of the paper’s approach to debt is not consistent with either the long-standing U.S. legal framework governing debt which acknowledges the propriety of defaults due to insolvency, or with social norms regarding debt where business-logic default (which is a more neutral term than strategic default) is common.

Third sentence

For consumption, the underlying question is whether underwater borrowers have a high marginal propensity to consume (MPC) out of either changes in total housing wealth or changes in immediate cash-flow.

The underlying assumption in this sentence is that mortgage policy had as one of its goals immediate economic stimulus, and that one of the choices for generating this economic stimulus was to use mortgage modifications to encourage troubled borrowers to increase current consumption at the expense of a future debt burden. In short, this is the classic financialization approach: get the borrower to focus only on current needs and discourage focus on the costs of long-debt. Most remarkably it appears that Tim Geithner actually did view mortgage policy as having as one of its goals immediate economic stimulus and that this basic logic was his justification for preferring payment reduction to principal reduction.[1]

Just think about this for a moment: Policy makers in the midst of a crisis were so blinded by the ideology of financializaton that they used the government mortgage modification program as a form of short-term demand stimulus at the cost of inducing troubled borrowers (i.e. the struggling middle class) to further mortgage their futures. And this paper is a full-throated defense of these decisions.

The ideology of financialization has become powerful indeed.

Financialization Post 2 will answer the question: What’s the problem with the ideology of financialization?

[1] See, e.g., the quote from Geithner’s book in Mian & Sufi, Washington Post, 2014


1 Mind you, I am skeptical as to how serious these threats were since servicers had incentives to play them up. The flip side is the FDIC made a concerted effort in 2010 to come up with ways to do mortgage modifications and they were stymied by the “tranche warfare” problem.

2 “Strategic default” was a meme that appeared with such suddenness after the crisis that it did not look organic. And as Sissoko points out, the idea that someone who defaulted before they were utterly broke was somehow abusing the system was widely accepted in the business press despite its lack of a logical or factual foundation. Someone who defaulted lost their house and everything that went with it: attachment to the neighborhood, whatever sweat investment they had made, all of the decorating. On top of that, they also trashed their credit score, which would not only hurt their ability to borrow but would also hurt them in the job market. Moreover, people who lose their houses still need to live somewhere. So if a borrower defaulted before he was totally out of dough so he’d have enough to put down a deposit on a rental and be able to move his goods, this paper would treat that as a “strategic default” as opposed to an anticipatory default (ie, the borrower knows he won’t be able to keep the house and exits before he is utterly destitute).

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  1. wellclosed

    As Michael Hudson has often said -debts that cannot be paid, will not be.
    How to vote against Banksters when both parties are drowning in them??

    1. Larry

      We simply have to keep voting for candidates that are not wholly owned by this ideology. It is an ideology that is past it’s sell-by date, as indicated globally by a rightward shift in global politics. Trump, Brexit, Bolsonaro and on and on. The Clinton wing of the democrats, which opposes anything progressive and has no ideas for how to govern effectively, won’t give up power easily. But they’re losing it anyway. Whether we get tipped more towards the right or get a politics that offers up solutions to the multiple crises we face globally remains to be seen.

      1. Brian (one they call)

        Thanks Larry; I was personally involved in the foreclosure nightmare. Came down to the only evidence presented to the court being a forged promissory note that when challenged, the court ignored. I have skin in the game. There was not 1 politician that stepped up and did anything to help the people of this nation. There wasn’t even lip service to a solution of hyper-hyphothefication of loans that broke the law by selling notes serially to multiple owners (a legal impossibility) How many of the foreclosures were done with fake promissory notes?
        Alas, there was no hero, they all took the payoff. The bribe. The bezzle, the fix.

      2. Indrid Cold

        Since the only issues that an be discussed in politics are variations on immigration, gender derived stuff and ‘nazi punching’, It’s not likely we will hear anything about liquidity constraits amongst the working classes.

    2. Paul Jurczak

      There are other parties. Take a long term approach. The problem is hard and there is no quick and easy solutions. Do it for the future generations.

      1. JTMcPhee

        How about a giant accidental unplanned unavoidable default, converted to a Jubilee of necessity?

        Naw, too many “interests” and rice bowls involved, looking for the last drop of blood from the turnip.


  2. Michael Olenick

    When I was in law school, back when we had to avoid dinosaurs while walking from the parking lot to the building, we were taught that minimizing losses was a core part of contract law. That is, there is an affirmative obligation to mitigate losses in a breach of contract situation. Say a person contracts to dig a hole for $100 and, halfway through, doesn’t come back. Three other parties offer to finish, one for $20, one for $50, and one for $100 and they’re all similarly credible with their ability to complete the task. The buyer, under these old theories (which, last I looked, still exist) to opt for the $20 bid then, after the hole is finished, they recoup their $20 plus whatever it reasonably cost to rebid the project and any other reasonable for foreseeable expenses.

    I bring this up because one side of a contracting party sometimes says, as the Mortgage Bankers Association did about a new headquarters they’d built, that it is cheaper to breach their obligation. In the case of our digger, she could have the job finished for $20 whereas it would have cost $50 for her time. It doesn’t matter if the reason for her breach was taking advantage of this economic opportunity or if she broke a bone and couldn’t dig or if aliens abducted her. This is the principle known as “strategic default” and there is nothing immoral or abnormal about it.

    Where things jumped the tracks in foreclosure land is that servicers routinely refused to mitigate defaults. Take Sayoc’s loan. He owned about $385K (plus interest and fees and all the other crap I’m ignoring that brought the judgment to the mid $400’s). They foreclosed and sold the house to a speculator for $165K. In a rational world it would have made much more sense to offer to reduce his principal to $250K and the interest rate, during a time of zero-interest money, to say 3%. That would’ve yielded the lender more money — it would have mitigated the default — leading to a better outcome for both borrower and lender, a more economically advantageous outcome which is the public policy behind the obligation to mitigate.

    Why didn’t they? Because a number of bankers decoupled economically efficient default with immorality. Just like they redefined moral hazard from it’s real meaning — insuring an asset one doesn’t own which gives a third party an incentive to (literally) burn it down (which happens to be exactly what happened with credit default swaps) — they also redefined default loss mitigation from an economic and legal concept to one based on morality. Not unlike those who argue against evolution they jumped from the science of economics to a religious morality that, as religious decrees often do, happened to favor themselves. Like I previously mentioned, at literally the same time they were defaulting on their own commercial mortgage after the property value dropped so it’s not like they were unfamiliar with this concept but, rather, were exhibiting the typical hypocrisy we’ve become accustomed to. To justify their stance they relied on a flawed paper, sponsored by Fannie Mae, that compared strategic default to a contagion, spreading like a virus if left unchecked.


    1. j84ustin

      I worked at a non profit where I facilitated modifications on behalf of homeowners for two years. I often too wondered why they wouldn’t modify nearly all of my clients’ mortgages, since it made financial sense. Alas, that was not the case.

      I had clients go down two tracks when it seemed we were going to be able to get a modification from the servicer: HAMP and non HAMP. Especially in the beginning, it was often too convoluted and the rules too narrow to qualify for HAMP (which often meant a guarantee of some sort of modification if one qualified) so I had to argue with servicers why homeowners should receive non HAMP modifications. When we did achieve them, as Yves said, they almost never were principal reductions (I can count on one hand how many of those we got). They usually were 1) reduced interest and 2) if that wasn’t enough to bring the payment down to what the servicer considered affordable, a term extension. As this usually kept the homeowner in the home, we counted these as successes. Unfair, but a success nonetheless.

  3. The Rev Kev

    “Strategic default”. Ah yes, I remember that meme making the rounds back then. Along with the one that it was all the fault of those who bought more house than they could afford. In short, the banks were the victims here of the wrong sort of people. I wonder if that is the story that the banks and the feds told themselves. That must have made “foaming the runway” with the bodies of the mortgage holders that much more comfortable. Puts me in mind of an award winning photo taken in this era. It showed a cop with his pistol drawn checking out an empty house that had been foreclosed on and the tragedy was that this was a house that until recently was a home with a family living there.

    1. leapfrog

      I hope you remember this one: John Courson, president and C.E.O. of the Mortgage Bankers Association, stated that homeowners who default on their mortgages should think about the “message” they will send to “their family and their kids and their friends.” Yet, in a “smart business move,” Courson defaulted on the MBA headquarters 79 million dollar headquarters.

  4. perpetualWAR

    What’s worse, is states’ attempt to assist, as in WA “Foreclosure Fairness Act” (first and foremost foreclosures will never be fair when banks are using forged documentation). The Elected that put forward the FFA, told me in a sit down, “Oh sure, I know this is a kick-the-can-down-the-road option, but we have to do something.” Never before did I realize they were not there to actually solve issues, until then.

  5. Tomonthebeach

    As somebody with way too many graduate courses in inferential and causal statistics, there is little doubt that it is possible to “prove” (or misprove) anything depending on which analytic club you remove from the statbag to drive your point down the fairway. A paper this year by Silberzahn et, al. in Advances in Methods and Practices in Psychological Science (Vol. 1(3) 337–356) amplifies my assertion. It also validates Mark Twain’s witticism about lies and damned lies.

  6. DonCoyote

    Ah yes, smuggle in your unprovable assumptions as facts at the beginning, and then proceed to the TINA conclusion.

    HAMP was a train-wreck from the beginning, but this attempt to distill poison from the lemons–feh.

    Excellent analysis, looking forward to the other parts.

  7. ewmayer

    Yes, this part from Monday’s NC article by Michael Olenick really leaps out at one:

    Sayoc’s house [purchased in 2006 for $400,000 with a 10% down payment – quite high by the standards of the late-stage housing bubble – and a $360,000 mortgage from Countrywide with an extremely predatory usury-interest rate of 9.88%, later refi’d down to a still-high 7.9%] was purchased at auction by PMG Mortgage & Lending Co., LLC on Nov. 12, 2009 for $166,500. PMG is a now-dissolved company that was located at 440 South Dixie Highway, Suite 200, Hollywood, FL, with one manager, Bruce M. Goldstein.

    So there was in the end a huge reduction in the principal, but of course the millions of poor homeower-shlubs who were underwater on these bubble-price-purchased properties all over the US were never offered same. I wonder how many folks, offered a 50% principal reduction, could have stayed in their homes? This is the kind of economic and legal-system injustice that runs rampant when one’s country, government and legal system have been hijacked to serve the Looter Elite.

  8. Jim A.

    ISTR early on in the mortgage crisis reading a paper that defined any default as “Strategic,” if the borrower was not already delinquent on all their other debts, without regard to their ability to service all their debts. And the moralistic framing was that the borrowers should have prioritized mortgage debt above all other debts, and that the banks could have had NO reasonable expectation that borrowers would choose to prioritize unsecured debt above debt “secured” by a house worth less than they owed.

    Of course the focus on the short term default and balance sheet effects on mortgage debt is strange considering that in a normal market, a mortgage is NOT advantageous compared to renting until several year have passed. Then the advantage of fixing ones principal and interest payments compared to ever rising rents makes up for the high transaction costs in RE. It is NOT necessary for a house to be fully paid off, to reap financial benefits from using a mortgage to purchase housing, but it DOES normally take five years or more.


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